Mumbai/Tokyo: The bond market in India reacted tepidly to Reserve Bank of India, or RBI, governor D. Subbarao’s saying there is room to cut interest rates as the impact of a global downturn is sharper than expected.
Bond yields fell to close at 6.36% from 6.48%. Before the announcement, the yields had risen as high as 6.51%. The weak reaction to the governor’s remarks was largely on account of the fact that the bond market has already factored in a 50 basis points cut in policy rates in the near term. One basis point is one hundredth of a percentage point.
“There certainly is room for cutting rates. The question is whether we should cut rates, when we should cut rates and by how much we should cut rates,” Subbarao said at an event in Tokyo.
Bond yields rose 5 basis points after Subbarao said: “It’s not automatic that inflation is coming down and you cut rates.” A lot of other variables enter into the calculation about adjusting policy interest rates, he said without elaborating.
Closely watched: Reserve Bank of India governor D. Subbarao. The central bank will hold its next policy review in April. Ramesh Pathania / Mint
India’s benchmark inflation dropped to one-year low of 4.39% for the week ending 31 January and RBI expects it to fall below 3% by end of March.
A top adviser to the Prime Minister, however, has said the high fiscal deficit could force RBI to wait before cutting rates.
Stand-in finance minister Pranab Mukherjee had estimated fiscal deficit to be 5.5% of gross domestic product in 2009-10.
According to bond dealers, the “fear psychosis” of higher borrowing still exists, because RBI has not yet detailed how much funds and of what tenure it will absorb through its open market operation.
The government recently announced an extra borrowing of Rs46,000 crore from the market which would take government’s gross borrowing from the market to Rs2.61 trillion, much higher than its original estimate of Rs1.45 trillion. It is expected to increase its borrowing further in the next fiscal year to a record Rs3.62 trillion.
However, the central bank has said that it would buy bonds from the market and ensure the government’s borrowing is carried out in the least disruptive manner.
RBI announced on Wednesday that it will buy back Rs6,000 crore in securities from the market. It will buy Rs3,000 crore of most-traded nine-year paper, Rs2,000 crore in 12-year paper and Rs1,000 crore in 26-year paper.
Reacting to the half-hearted response of the bond market to the governor’s rate-cut comments, R.V.S. Sridhar, senior vice-president, treasury, Axis Bank Ltd, said: “There is still discomfort in the market in terms of borrowing and the RBI will probably not use all of its weapons in its armoury at one go.”
“A 50 basis points cut is already factored in yields since the last 15-20 days. A cut of that much won’t do any good for the market,” said J. Moses Harding, executive vice-president, wholesale banking, at IndusInd Bank Ltd. “Only if there is a cut of 100 basis points or so, it would come as beyond expectations and we would see some positive movement in yield.”
In his prepared speech in Tokyo—the text of which is available on RBI’s website—Subbarao said, “The outlook for India going forward is mixed,” as economic activities slowed down, growth rate moderated and services sector, “which has been our prime growth engine for the last five years,” slowed down and exports declined.
“Recent data indicate that the demand for bank credit is slackening despite comfortable liquidity in the system. Higher input costs and dampened demand have dented corporate margins while the uncertainty surrounding the crisis has affected business confidence,” he said.
The Index of Industrial Production, or IIP, a key indicator of the country’s factory output, has shown negative growth for the past two months, even as investment demand is decelerating.
Growth is projected to slow to 7.1% this fiscal year ending 31 March, from 9% and above in the past three years.
However, India has several advantages to tackle the crisis, most notably being the faster than expected fall in inflation due to falling commodity prices, and to some extent, slowing domestic demand, Subbarao said in his speech.
“Since a large majority of Indians do not participate in equity and asset markets, the negative impact of the wealth loss effect that is plaguing the advanced economies should be quite muted,” the governor said.
RBI will hold its next policy review in April, although it can change rates between reviews. At its most recent review in January, the bank left its policy rates unchanged but has brought down its key policy rate to 4% through a series of cuts since October.